9th Australasian Capital Confidence Barometer

Inside

Q. What is the primary reason for not pursuing acquisitions in the next 12 months?

Deal-making back on the agenda

Planned acquisitions have returned to their April 2011 levels. Expectations for deals between $500 million and $1 billion have more than doubled in the past six months.

Yet, this is still a cautious M&A environment. While almost 70% expect to see greater deal volumes, only about a third are planning to participate in M&A. Many also expect a proliferation of smaller deals. But executives know this is a good time to buy. The valuation gap — already at 10-20% — is expected to widen. Prices are likely to go up as more buyers chase a still constrained supply of targets. Those with growth on the agenda have few other places to turn. M&A activity will pick up – and there will be substantial first mover advantages for those prepared to jump first.

Acquisitive growth is back on the agenda, but businesses are still exercising caution. Almost 70% of respondents anticipate a modest improvement in local deal volumes in the next year and 34% expect to pursue an acquisition in the next 12 months. Compared with 20% a year ago, the trend is decidedly upwards. For only the second time in two years, the local appetite for acquisitions exceeds the global average.

Not surprisingly, in this early stage of the cycle, the messages around likely deal sizes are mixed. Although forecasts for the number of deals between US$501m–US$1b have more than doubled, expectations for deals under $50m have also increased from 33% to 40% in the past six months. It seems it will be a while before we see mega-deals back on the table.

Deal-making momentum may be building slowly, but it is being driven by the desire for growth, not tactical gains. Winning share in new and existing markets are the standout drivers for planned acquisition activity. Far fewer respondents see acquisitions as a way to reduce cost/improve margin or leverage distribution networks, as the level of incremental returns in these activities is slowing.

Valuation gap expected to widen

Companies hesitating to jump into M&A activity should be aware that both prices and the valuation gap are only likely to increase. Almost half of the local respondents expect prices to increase in the next 12 months. As many as 59% believe the current valuation gap is between 10-20%, with 38% of respondents expecting this gap to widen — compared with 12% six months ago. Companies should consider the benefits of acting now, while there are still reasonably priced assets on the table. Those currently being put off by the valuation gap should be aware — it’s only going to rise.

Activity held up by regulatory uncertainty

The regulatory environment is the main reason for respondents not pursuing an acquisition. Over 30% of companies are concerned by this, up from 23% in April. Clearly, at the time, executives remained uncertain about whether or when the carbon and mining taxes would be repealed in Australia. Once the market has certainty around the regulatory environment, we can expect a further lift in confidence and M&A activity.

A quarter of respondents said they were deterred by insufficient opportunities, indicating a build-up of demand. As buyer demand grows, this pull factor will cause more sellers to move into the market, adding more fuel to the fire.

Australasian companies have cited sales volume decline, overestimating strategic value and unforseen liabilities as the three key reasons for recent acquisitions not meeting expectations — issues which can be mitigated with robust pre and post deal integration. With an increasing number of companies pursuing deals to achieve growth, we expect to see companies focus much more sharply on achieving both the cost and revenue synergies that were identified in the deal process.

Comprehensive planning for the post deal integration — or separation, if a divestment — is the best way to avoid value erosion.

Divestment moves from defence to offence

Divestments are no longer about raising cash to compensate for underperformance. Whereas, six months ago, this was the driver for 42% of divestments, by October 2013 it was no longer an issue. Instead, companies are divesting to focus on core assets or enhance shareholder value. Fund raising for inorganic or M&A growth is also no longer a driver.

The predominant structure for divestments continued to be business unit sales. More than half (55%) expect to sell a business unit. Far fewer (15%) expect to exit through an IPO, compared with 26% six months ago, although this channel is likely to increase as the cycle progresses. The number of companies considering contributing a business unit to a joint venture increased from 9% to 15%.

Those put off divesting were largely concerned about the potential for an adverse market reaction, execution risk and business disruption. Only 26% believed they could not get the price they wanted for the asset.

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